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posted on 01 September 2016

August 2016 ISM Manufacturing Survey Returns to Contraction

Written by Steven Hansen

The ISM Manufacturing survey slipped slightly into contraction after five month in expansion. The key internals declined and are in contraction. The PMI manufacturing Index, also released today, is in positive territory and marginally declined.

Analyst Opinion of the ISM Manufacturing Survey

Based on this survey and the district Federal Reserve Surveys, one would expect the Fed's Industrial Production index to be unchanged for August. All manufacturing surveys for August have been around the zero growth line (either slightly in expansion or slightly in contraction. ADP's employment for manufacturing was unchanged also for August. Manufacturing seems flat.

The ISM Manufacturing survey index (PMI) marginally declined from 52.6 to 49.4 (50 separates manufacturing contraction and expansion). This was slightly below expectations which were 51.3 to 53.0 (consensus 49.4).

Earlier today, the PMI Manufacturing Index was released:


Released On 9/1/2016 9:45:00 AM For Aug, 2016
Prior Actual
Level 52.9 52.0

Markit's U.S. manufacturing sample continues to report month-to-month growth but slow growth. The PMI for August came in at 52.0 which is only modestly above the 50 level that divides monthly growth from monthly contraction. Growth in new orders slowed which is a key negative in the report, along with slowing in employment. The sample is also cutting its inventories which points to lack of confidence in the business outlook. Price data are flat which is yet another indication that demand is soft. But there are positives including strength in production, which however won't last long if orders remain weak. And there's an important indication of strength in orders as new export orders posted a rare gain. This report in sum points to no better than flat conditions ahead for manufacturing.

The regional Fed manufacturing surveys are mixed, and now the ISM indicates manufacturing shows contraction.

Relatively deep penetration of this index below 50 has normally resulted in a recession.

The noisy Backlog of Orders declined and remans in contraction. Backlog growth should be an indicator of improving conditions; a number below 50 indicates contraction. Backlog accuracy does not have a high correlation against actual data.

Excepts from the ISM release:

Economic activity in the manufacturing sector contracted in August following five consecutive months of expansion, while the overall economy grew for the 87th consecutive month, say the nation's supply executives in the latest Manufacturing ISM® Report On Business®.

The August PMI® registered 49.4 percent, a decrease of 3.2 percentage points from the July reading of 52.6 percent. The New Orders Index registered 49.1 percent, a decrease of 7.8 percentage points from the July reading of 56.9 percent. The Production Index registered 49.6 percent, 5.8 percentage points lower than the July reading of 55.4 percent. The Employment Index registered 48.3 percent, a decrease of 1.1 percentage points from the July reading of 49.4 percent. Inventories of raw materials registered 49 percent, a decrease of 0.5 percentage point from the July reading of 49.5 percent. The Prices Index registered 53 percent, a decrease of 2 percentage points from the July reading of 55 percent, indicating higher raw materials prices for the sixth consecutive month. Manufacturing contracted in August for the first time since February of this year, as only six of our 18 industries reported an increase in new orders in August (down from 12 in July), and only eight of our 18 industries reported an increase in production in August (down from nine in July).

Of the 18 manufacturing industries, six are reporting growth in August in the following order: Printing & Related Support Activities; Nonmetallic Mineral Products; Computer & Electronic Products; Miscellaneous Manufacturing; Food, Beverage & Tobacco Products; and Chemical Products. The 11 industries reporting contraction in August — listed in order — are: Electrical Equipment, Appliances & Components; Apparel, Leather & Allied Products; Plastics & Rubber Products; Furniture & Related Products; Transportation Equipment; Machinery; Textile Mills; Paper Products; Petroleum & Coal Products; Primary Metals; and Fabricated Metal Products.


It is interesting to note that ISM Manufacturing represents less than 10% of USA employment, and approximately 20% of the business economy. Historically, it could be argued that the production portion of ISM Manufacturing leads the Fed's Industrial Production index - however the correlation is not strong when looking at trends.

New orders have direct economic consequences. Expanding new orders is a relatively reliable sign a recession is NOT imminent. However, New Orders contraction have given false recession warnings twice since 2000. This month new orders declined but remains in expansion.

However, holding this and other survey's Econintersect follows accountable for their predictions, the following graph compares the hard data from Industrial Products manufacturing subindex (blue bar) and US Census manufacturing shipments (red bar) to the ISM Manufacturing Survey (purple bar).

Comparing Surveys to Hard Data

z survey1.png

Caveats on the use of ISM Manufacturing Index:

This is a survey, a quantification of opinion - not facts and data. However, as pointed out above, certain elements of this survey have good to excellent correlation to the economy. Surveys lead hard data by weeks to months, and can provide early insight into changing conditions.

Many use ISM manufacturing for guidance in estimating manufacturing employment growth. Econintersect has run correlation coefficients for the ISM manufacturing employment and the BLS manufacturing employment data series above going back to 1988, using quarterly data. The coincident correlations are actually negative, but poor (r = -0.2 to -0.4 for various time periods examined). See here for definitions.

Before 2000 the ISM employment data had a weak positive correlation to the BLS data 4 to 7 quarters later (r values above 0.6). Since 2000 the correlations for ISM manufacturing employment as a leading indicator for the BLS manufacturing employment have been between 0 and 0.3 for r (correlation coefficient). These values define correlations as none to poor.

In other words, ISM employment index is not useful in understanding manufacturing jobs growth.

The ISM employment index appears useful in predicting turning points which can lead the BLS data up to one year.

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